Looking into the Crystal Ball: A Forecast and Some Risks for the Year Ahead: Speech Delivered to the Canterbury Employers' Chamber of Commerce, Christchurch, 28 January 2011

Bollard, Alan, Lees, Kirdan, The Reserve Bank of New Zealand Bulletin

Introduction

For New Zealanders, Christmas and New Year are the times for family, relaxation and reflection on the year past. January is the month when we traditionally look ahead, and consider what the year may hold. This speech presents our economic view of 2011, and then poses a series of international and domestic risks to that forecast. Of course our forecasts will not turn out to be completely accurate. The risk analysis is a way to examine some of the complexities that may affect us.

What we can and cannot forecast

There are limits to what we, the Reserve Bank, and indeed any economists, can forecast. Like meteorologists, economists have a reasonable understanding of what might happen in the near term, but over the longer term, perhaps beyond six quarters or so, uncertainty begins to increase. We generally find we can predict movements over the business cycle but struggle to adequately deal with big changes in structures or behaviours.

Over the long term, we resort to analysing patterns and trends in the data in ways not dissimilar to how meteorologists look to la Nina and el Nino events to help understand the longer term picture. These patterns and trends do contain useful information but, like long-term weather forecasts, provide limited comfort if you want to know if it will rain on your wedding day in Christchurch in early summer.

We regularly assess our forecast performance and look for ways to improve what we do. We find our activity forecasts a year ahead are reasonably accurate and likewise, we can forecast some price information, particularly for that part of the economy little affected by international trade. However, exchange rates and international prices are much harder to forecast.

Of course forecasting has been particularly difficult as the world pulls out of the Global Financial Crisis. People's behaviours and business's behaviours have changed significantly and we have little from history to guide us about how enduring or deep these changes may go. In addition, the recovery has been rocky and fragile. In this speech we go further and look at some "what-ifs", identifying some economic developments that could make a sizable difference to our forecast picture. We examine a number of international and domestic scenarios that could conceivably impact us. These scenarios contain both "good" and "bad" outcomes, and some have perverse or indeterminate collateral implications that make it hard to classify them.

Moreover, these scenarios are not necessarily independent events. Interactions between shocks can be complex and important; and when it comes to the Global Financial Crisis, nothing is simple. For example, Howard Davies' recent book documents 38 different things that went wrong during the Global Financial Crisis. (1) Many of these were inter-related, and those interrelations made the situation worse.

But before we turn to the risks to our outlook, we will focus on what we think will happen over 2011, based on our view at the time of the latest Monetary Policy Statement, updated for data over the last month.

What we think will happen over the next year

The Global Financial Crisis was a deep and damaging event. Even in New Zealand where we have been less affected, recovery has been slow and patchy. In fact, 2010 was a disappointing year: we initially saw recovery happening, but the second half went unexpectedly soft (as it did in many OECD countries). During 2011 we expect the recovery to pick up and gradually become more secure.

The international outlook continues to be uneven. Growth in the Asian region has been strong but has brought its own difficulties with inflation and asset price bubbles building. The outlook for Western and developed economies is still spongy as these economies slowly recover from the aftershocks of repairing damaged bank balance sheets and ongoing government fiscal exposures. …

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